Pork Demand: Key To Producers' Future

On the surface, the concept of demand sounds quite simple. When we dig for more detail, however, we find that while it is not a complicated issue, it is not intuitively clear to everyone either.Coming off disastrous 1998 prices in the pork sector, and facing the need to get back to where a well-managed program has a chance to make a profit, it is a good time to look at the factors that will determine

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On the surface, the concept of demand sounds quite simple. When we dig for more detail, however, we find that while it is not a complicated issue, it is not intuitively clear to everyone either.

Coming off disastrous 1998 prices in the pork sector, and facing the need to get back to where a well-managed program has a chance to make a profit, it is a good time to look at the factors that will determine the industry's long-term future. And we will find that the long-term viability of any sector that produces, processes and sells a food product to the consuming public is going to be determined by what happens to demand.

There are countless indications that many people see per-capita consumption as synonymous with demand. This is a bad mistake, a mistake that leads us down the wrong paths in terms of strategic planning.

Figure 1 shows per-capita consumption of beef, pork and broilers since 1960. We see clear patterns on that chart, especially across the past 20 years. Per-capita beef consumption trends lower, per-capita broiler consumption trends higher. Pork has been relatively stable. What message can we glean from these long-term series?

The Per-Capita Message On a per-capita basis, beef supplies have dropped from 95 lb., on a retail weight basis, in 1976 to a projected 65 lb. in 1999. The beef message - resources have not been kept in beef production, processing and distribution at a level that would maintain prior levels of per-capita supplies. There has not been sufficient profit potential to attract investments into beef production and processing.

On the other hand, it is apparent that investments have moved into chicken production. Since we know the investment dollar tends to chase profit potential, we can infer that profitability has been a lot better in the poultry sector (and it has).

The message from pork is not at either of these extremes. There has been no reason for this industry to grow on a per-capita basis. There has been no sustained investment in expanded production and processing capacity.

What we can conclude from this brief examination is that per-capita consumption measures per-capita supply. Or, more technically, it measures per-capita availability after accounting for exports and imports.

But, per-capita consumption says nothing about demand. Demand has a "willingness-to-pay" component. Technically, we define demand for any particular pork product as a schedule of all of the quantities that consumers will take at alternative prices. That suggests, at any point in time, that the only way you can sell more pork is at a lower price.

Conversely, if for some reason you have less pork to sell, consumers will pay a higher price for it. Demand cannot be simplified to be synonymous with a measure of availability or supply such as per-capita consumption.

What Does It Mean? Now, let's step back and think about what this means to pork producers. Let's assume that 50 lb. of pork is being offered on a per-capita basis in the U.S. in a particular year. That per-capita supply has been largely predetermined by breeding decisions and herd expansion or contraction decisions in the prior year. We know that those expansion and contraction decisions depend on price expectations, cost of feed, interest rates and a number of other considerations that influence the profitability of the hog business.

But, again assuming 50 lb. of pork is being offered this year, what would prompt an expansion and encourage producers to offer more pork in the following year?

The answer is apparent - the possibilities of being profitable.

What brings the possibility of profits and potential?

Unless you can find a way to significantly lower production costs, those profit possibilities pivot on the price that consumers will pay for your product. This is true whether the product goes to retail grocers, through the hotel, restaurant and institution trade, the fast-food restaurants spread across the U.S, or into export channels.

It seems apparent, then, for an industry to grow, and at least, periodically, make profits, we need a consumer who is willing to pay attractive prices for the product.

There are reasons to have concerns about what is happening to the price spreads between the consumer and producer when retail prices of pork get "sticky" and do not respond quickly to changes in hog prices. But we do know that, over time, if consumers are willing to pay a higher price for the retail offering, it will eventually show up in the form of higher hog prices.

Where will higher prices come from? Obviously, one way is to substantially reduce the amount of product being offered. When you do that (and we do on a cyclical basis), hog prices get pushed higher no matter what is happening to the demand side of the price equation. But that path to higher prices is self-defeating because it comes at the expense of downsizing the industry, pushing producers out of business and losing market share.

That is essentially what has been going on in beef for some 20 years - and that is not the path to a successful sector. Pushing prices up by reducing pork production will not make pork the "meat of choice."

Wanted: A Robust Demand What we need, then, is robust demand. That is, a willingness by consumers to pay up for the product offering and to finance, with their increased dollars, growth and expansion in pork production and processing.

For consumers to offer that opportunity, they have to like what they are being offered. In other words, it is critically important that the industry has to make sure that the pork product offering is aligned with what a modern, often fickle, consumer wants, prefers and is willing to pay for.

Have we done a good job on that side of the price equation?

A quick look at Figure 2 suggests that the industry has been less than successful in attracting the consumers' dollars. This plot shows per-capita pork consumption and retail pork prices after they have been adjusted for inflation and converted to 1982-84 dollars. (We remove the influence of inflation before comparing prices across years because we want to know what is causing pork prices to change in a basic supply and demand context.) By dividing the pork prices by the consumer price index for each year, we remove the influence of inflation and we have everything in a common denominator. We can then legitimately compare across years.

There was a period, especially 1980 to 1988, in which the paths these two series were following had some ominous implications. Both quantity and price were declining. That is a textbook example of decreasing demand. Having to sell smaller offerings at lower prices is a recipe for disaster. Unless that pattern can be changed, we are headed for a much smaller industry and a much smaller market share.

Figure 3 on page 74 presents the same price and per-capita consumption data in a different context. This is a scatter plot of per-capita consumption and inflation-adjusted prices from 1960 to 1998.

I have imposed a demand curve on this graph to suggest what a particular level of demand might have looked like back in 1980. This particular demand curve is drawn so that it passes through the coordinates for 1980. Per-capita consumption was 56.4 lb. and deflated retail price was $1.69. If you visualize a curve with roughly the same slope and same curvature coming through a recent year, like 1998, it is clear that those demand curves in later years would have been down and toward the origin compared to the 1980 baseline. It is important that we reflect on what that means.

As we mentally sketch the demand curve through 1998, visualize this curve as being essentially parallel to the one in Figure 3. That is doing a bit of injustice to the true parameters in this situation, but it helps us make the point. Look at how much higher the price for the 1998 per-capita offering of 52.8 lb. would have been if we had still been on the demand surface that prevailed in 1980 (shown where the vertical red line intersects the curve). The 52.8 lb. per capita in 1998 was consumed at an inflation-adjusted price of $1.41/lb. But, using the 1980 baseline price, it should have been near $2/lb., some 40-55% higher. Hog prices would have been higher by about the same percentage.

Clearly, there has been a substantial decrease in demand as measured by the willingness to pay for a particular quantity of product during the 1980-98 period. As implied by the line plots in Figure 2, those problems were most apparent during the first half of the 1980s and then again up through about 1995 in the 1990s. There was a rapid movement down and toward the origin and the pattern was a most negative one of consumers taking a smaller per-capita offering of product only at lower prices.

Magnitude Of Decline At this point, it is always useful to try to put some numbers on the magnitude of the demand declines. Usually, there is a tendency to oversimplify here, but it still helps to get some idea of how deep the pain has been.

Table 1 provides an index of demand for pork, again using 1980 as a baseline or point of departure. I have adjusted the price each year after 1980, using a concept of demand called "elasticity" to show what the price would have been if the demand in later years had been the same as it was in 1980 (see "demand constant price" column). I then compare that constant demand price, which reflects only the price influence of a change in quantity as compared to 1980, with the actual inflation-adjusted price for later years. This allows me to build an index with 1980 as 100 and to register the decreases in demand in subsequent years.

Notice that the index for 1998 is 76.22. This suggests that the demand for pork from 1980 through 1998 had fallen by nearly 24%. It is also interesting to note that the index levels for many of the years in the late 1980s and into the 1990s are roughly the same.

One problem with the simple construct shown in Table 1 is that we have no notion as to why demand for pork declined. Was it due to cheaper, substitute meats? Was it due to stagnant consumers' incomes, thus reducing their willingness to buy some pork products? Or was it a taste and preference problem as the variety and form of pork offered increasingly did not fit a modern, on-the-go lifestyle? Was it inconvenient to prepare? Were there consistency and quality problems?

We can't tell what caused demand for pork to decline by looking at the numbers in the table; we just know it declined. And our examination of the data in Figure 3 suggests that when all these forces are present, the decline appears to have been in excess of 40%.

Data Helps Explain Price Changes A late 1998 analysis called "Changes in Demand for Beef, Pork and Chicken, 1975-1998," available on the Internet at www.aaec.vt.edu/rilp/, provides an updated modeling effort through 1998. The results are very interesting.

The model used pork quantity, measures of the substitutes (beef and chicken) and consumers' incomes to explain changes in pork prices. But examination of the results showed some demand-shifting force was not included.

The other important "demand shifter" is preferences, a force we cannot measure directly.

Shift variables were added to pick up the changes in pork prices not being explained by changes in pork quantity, the substitute meats and consumers' incomes.

Starting in 1980, the signs on these shift variables were negative, and they were negative through 1998. The most negative coefficient was from 1995, with some moderation from that extreme level in 1996, 1997 and 1998. Care is needed here, because the shift variables pick up anything that is acting on pork prices. But the sustained pressure is coming, in my opinion, from the preference issue. Consumers have not been highly pleased with the quality, consistency, variety and especially the convenience of fresh pork offerings.

Don't Miss The Message Lest we get lost in the complexity of some of these measures, it is important that we come back to the important message: Consumers' dollars are the only dollars that are available to the industry to be divided across all the industry participants, and it is consumers' dollars that will determine whether or not there is enough to go around and allow profitability at different levels.

If your operation is getting smaller or having to disinvest over time, it is because the price that the consumer is willing to pay is not sufficient to maintain profitability in production and processing of the product. To change this trend and move back to the point that the sector is growing and building market share again, we have to recognize that share will be claimed primarily by taking eating capacity for meats away from beef, lamb, chicken, seafood and other sources of meat-based protein.

For this to happen, you have to put a product in front of the modern consumer that they like better than the alternatives. It will require a product they see as having more value, per dollar spent, than the other meats.

This means that it is extremely important that investments be made in new product development and new market development. There must be a constant vigil and constant effort to modernize the product offering to keep it moving toward what the modern consumer wants and is willing to pay for. This is the only path that leads back to the status of growth. It is the only path that leads back to a posture of economic viability where at least, periodically, the well-managed operation at the producer level has a chance to make a profit.

What Is Needed? Having said all that, it might be useful to stop and reflect even more on specifically what needs to be done.

Let's recognize that there are many pork consumers who like the product, who will spend some time preparing it and who are faithful pork eaters. Now, let's focus on the family with two adults working outside the home, both following professional career paths, with one or two children of varying ages in the home. We know this family is generally well educated. We know it generally makes a lot of money. We know, typically, one person in the family (not always the woman) accepts the major responsibility for food preparation. We know also that they start thinking about the evening meal somewhere between 4:30 p.m. and 6 p.m.

That orientation rules out a significant number of the fresh pork offerings that consumers would see if they get off a commuter train and rush into a grocery store. A pork roast is not going to do it. Nor will anything else that is going to require a significant amount of preparation time.

This consumer may buy the relatively higher-priced ham that is 95% fat free. He or she may buy pork chops, especially during grilling season. But increasingly, there is a desire for even further value-added processing that would make that meal experience even easier and the consumer is willing to pay for value added. Every economist would agree that modern consumers will pay for convenience as their incomes go up and they can "buy" time away from meal preparation.

Pre-cooked products, in either entree or whole-meal form, that can be cooked in the microwave for a matter of 3-5 minutes will have great appeal, especially if these are delicious, nutritious, well-prepared and well-garnished offerings. The nicely done product in the frozen entree counter, which again requires only 4-5 minutes in the microwave, will also have some appeal.

Keep in mind how much, on a per-pound basis, is often paid for ham, pork or other products when you pass through the deli and pick up items and side dishes that can be put in front of family members within just a matter of minutes. It is these paths that we have to explore in bringing the product to an even closer alignment with what the modern consumer wants and is willing to pay for.

The industry needs to find a way to go down these paths, to become consumer driven and serve those modernistic needs, to restore growth and profitability.

What's The Holdup? Why isn't this being done more aggressively?

In the traditional industry with separate ownership at the producing, processing, value-added further processing and retailing levels, there has been no particular player in the system that has had the economic incentive to make the investments in new product work.

It was not until some of the larger processors started getting control of the genetics, reducing quality variation required for a branded product with some quality assurances, that we started seeing some of the new products come on line. This is one of the primary, but not the only, motivations for the integrated, contractually controlled systems we are starting to see emerge in pork. It is a mixed blessing, perhaps, to many producers in the sense that being a participant in the type of controlled system we are starting to see costs them some of their historical independence.

The ongoing changes clearly have some pros and cons associated with them. We must be consumer driven. We need to recognize that one of the positives coming out of all this is that we are finally starting to see the significant investment in product and market development necessary to put pork products in a much stronger position in front of the increasingly discriminating consumer.

If it is important that we maintain an industry structure that has independent entrepreneurs involved in it, then they must find a way to get themselves aligned with the rest of the pork processing and distribution system. The needs of consumers can and must be served.

If we don't find a way to do that, then I think we will see the profit opportunity associated with better serving the consumer continue to drive the industry toward closed, integrated systems. Most of us who work with, think about and identify with the producer level would not like to see that happen.

But we do have a choice. We can understand what we need to do as an industry to be consumer driven and bring back growth and profitability. If we understand what must be done, I think we can find various ways to get it done. It does not require vertical integration. It does, however, require vertical coordination. That means coordinating the producing, processing and retail activities without going to totally vertically integrated systems like we have seen in poultry for decades.

How it gets done may still be up for grabs. Whether it will be done is no longer in question.

Serving the wishes of the consumer can be very, very profitable. That increasingly clear profit incentive will push this sector toward growth and expansion. It will, I predict, mean the big increases in per-capita supply during 1998 will not be completely washed out during the current, cyclical liquidation. The sector will have taken an irreversible step up to a bigger market share. It will be most interesting to see who is along for the ride as the pork sector grabs the opportunity associated with consumers' willingness to pay for a product offering that fits their preferences and their on-the-go lifestyle.